Franchising: Is it For You? Part I
In the last
issue of this newsletter, we looked briefly at what franchising is all
about. In this issue, we will explore how to tell if a franchise is right for
you.
Franchises, as a
business opportunity, have some advantages and disadvantages.
One common advantage of franchises is that the franchisor places national
or regional ads which benefit all of the franchisees.
Nearly all fast food franchises of any size have national media outlets
which promote the franchise in the media and at major sporting events.
Franchisees benefit
from the national exposure and the chance to get their product or service known
to many more people than would be possible with only local advertising. But what
if the franchisor runs into cash flow problems and fails to do effective
national marketing? In such cases, the interdependency of the franchisee and the
franchisor becomes critical.
This is why it is imperative that anyone thinking of purchasing a franchise must thoroughly investigate both the franchise offering and the franchisor.
One of the required
disclosures in the Uniform Franchise Offering Circular is financial statements
of the franchisor. These must
be carefully studied to make sure that the franchisor will have the financial
ability to live up to its end of the bargain.
A well run and well
organized franchise system can help an entrepreneur get started and succeed in
business with less capital and experience than might otherwise be required.
On the other hand, there are some very definite risks associated with
franchises which a potential franchisee must fully understand.
From the standpoint of
a potential franchisee, the task of doing due diligence in investigating the
franchise offering involves many components. For example, if there are other
competitors, whether franchised or not, in the same area offering the same or
similar products or services, such as home inspections, how will a franchisee
succeed? Will the franchisee be competing with other franchisees of the same
brand?
The decision whether to
market a business through a franchisor is a difficult choice to make, involving
a complex interplay of legal and economic factors.
The guidance of an attorney and an accountant knowledgeable about
franchise matters is essential.
The trade-off for the
benefits of a franchise — a national brand and guidance and marketing support
from the franchisor — is the cost of paying a percentage of sales to the
franchisor and giving up considerable control to the franchisor.
Franchise agreements
often require franchisees to follow strict rules about the operation of their
business as well as to incur various financial obligations. It is essential that
any franchisee fully understand, before anything is signed, the obligations
(financial and otherwise) that are imposed by a franchise agreement.
We all know businesses
or restaurants that sell a particular service or product and do well without the
need for the support of a franchisor. One advantage of being successful without
a franchise is escaping the constant payment of the royalty to the franchisor,
which means that the non-franchisee gets to keep a greater percentage of the
gross receipts.
In the last
issue, we talked about the need for a business plan.
This is particularly important for a franchisee, because the franchisee
may be contractually obligated to incur a number of expenses to the franchisor
and have little control over reducing such expenses.
The franchisee must
also realize that many decisions regarding the operation of the business will be
made by the franchisor. For example,
Hen Doodles (hereafter “Hen”), requires its franchisees’ employees to wear
red hats looking like chicken combs. If one franchisee thinks this is ridiculous
and refuses, Hen may contractually force the franchisee to comply or terminate
the franchise.
Both franchisors and
franchisee sometimes fail, for a variety of reasons. If the product is defective
or if the franchisor does not properly manage the franchise effort, the entire
franchise may fail. If that were to happen, the franchisees essentially have
lost their money.
Franchisees, even with
successful brands, can also fail, because of poor planning or poor execution. In
that respect, franchises are like most other small businesses. Good planning is
always essential.
Copyright 2004
Published by the law firm of Newland & Associates, PLC
9835 Business Way
Manassas, VA 20110
Call us at (703) 330-0000 for a full range of business law and
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While designed to be accurate, this publication is not intended to constitute the rendering of legal, accounting, or other professional services or to serve as a substitute for such services.
Redistribution or other commercial use of the material contained in Newland's Business Notes is expressly prohibited without the written permission of Newland & Associates, PLC.
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